According to conventional wisdom among Washington-based policy experts and trade groups representing the housing and mortgage finance industry, the primary reason for nonbanks taking up a bigger piece of the FHA pie is a raft of lawsuits filed against big banks under the False Claims Act. These lawsuits charge that the FHA-insured mortgages originated by big banks in the period leading up to, and including, the 2007-08 financial crisis were of poor quality that failed to meet FHA standards.
According to this reasoning, the large-dollar financial settlements reached in most of these lawsuits have persuaded big banks to dial back their activity in the FHA single-family program. Apparently, big banks believe that the FHA program exposes participants to a high degree of risk that banks can't adequately control, as demonstrated by the lawsuits and subsequent settlements.
As big banks have retreated from the FHA market, independent lenders and mortgage banking companies have filled the gap and become the dominant FHA lenders.
Since the FHA program serves a high proportion of first-time homebuyers and minority homebuyers, one would think that the housing and mortgage finance establishment would welcome the increased involvement of independent lenders and mortgage bankers. Sure, these lenders have not increased their FHA-insured lending for altruistic purposes. Rather, they spotted a business opportunity and have moved to capitalize on that opportunity. But the borrowers served by the FHA program, particularly first-time buyers and minorities, have benefited from the increase in those institutions' lending activity.
Many, if not all, of these independent lenders and mortgage banking companies have long been involved in the FHA program. Arguably, in the course of this long involvement, independent lenders have developed a high degree of expertise in the FHA program — which is another important factor behind the increase in their origination volumes and market share.
Yet you would never know any of this from some of the reaction. For example, Laurie Goodman and Jim Parrott of the Urban Institute recently published a piece directed towards the next HUD secretary on how to strengthen the FHA. They urge the new administration to pull back on the use of the False Claims Act because "well-capitalized lenders are increasingly deciding this risk isn't worth taking and have pulled back dramatically from their FHA lending." This type of reaction and other statements like it amount simply to handwringing — a negative focus on the retreat of banks and bank-owned lenders from the FHA market and the rise of "less capitalized" lenders in their place.
This handwringing has been accompanied by proposals to "reform" the FHA-insured program to make it more welcoming and friendly to big banks so that may increase their origination of FHA-insured mortgages. For example, one proposal would have FHA create a series of penalties matched to the level of mistakes, i.e., more serious mistakes incur larger penalties. That certainly makes sense, but it also implies that these large settlements that big banks paid were for minor mistakes. Major institutions willingly paid multibillion-dollar settlements for minor mistakes, really?
These proposals aimed at helping large banks never make mention of the quality of FHA-insured loans that big banks originated in the run-up to the crisis. The quality of big banks' FHA originations, or perhaps better put lack of quality, led to the False Claims Act lawsuits and large-dollar volume settlements in the first place. The fact that the bank and bank-owned mortgage companies were sued for poor loan quality and agreed to large-dollar settlements arguably should raise questions about their being in the FHA program.
Independent lenders and mortgage banking companies have stepped up to fill the void in the FHA single-family program created by the retreat of the big banks and bank-owned lenders. They should be commended for having done so, rather than be the target of condescending comments.
Many of these independent companies are family-owned or owned by their management teams. These owners put their entire financial net worth and that of their families on the line every day with the lending and business decisions they make. How many big bank executives can say that? Independent lenders have put their livelihoods at risk by increasing their involvement in the FHA program as the big banks have retreated. They have done so because they are confident in their ability to follow FHA's rules and originate quality loans, which is amply demonstrated by the current low level of defaults in the FHA program. In doing so, they have kept credit flowing to first-time and minority borrowers.
As for the big banks, if they are willing to play by the rules of the FHA program and originate quality loans, then they should be welcomed into the program. If instead they are interested in gaming the system and changing the rules so they can originate loans of dubious quality, then the Department of Housing and Urban Development should close the door firmly in their faces.
Glen Corso is executive director of the Community Mortgage Lenders of America, a trade association for midsize and small, independent, community-based lenders.